Funds that can generate an income in the “fixed interest desert”, play one of the best long-term themes in today’s markets and profit from a likely uptick in volatility are among those that Psigma Investment Management is backing for the year ahead.
Last year ended up being a strong one for markets, despite many investors going into it with a sense of nervousness. FE Analytics that large parts of the equity market posted double-digit gains in 2018 with emerging markets rising about 25 per cent.
At the same time, volatility – indicated in the below chart by the CBOE SPX Volatility Index (the Vix) – dropped to historic lows on the back of continued loose monetary policy and strong market momentum.
Performance of indices over 2017
Source: FE Analytics
“Our expectation is that 2018 will be somewhat similar to 2017 from an economic perspective, although growth will moderate through the year back to a similar level that we have experienced since the financial crisis of 2008,” Psigma Investment Management said.
“Risks undoubtedly exist, despite the bullish chants of the optimistic chorus. A return of inflation, interest rate rises and a slowdown in China are the preeminent risks we are evaluating as we head into next year. We expect our portfolios to make low positive returns next year, but any gains are likely to be driven by specific and selective investment opportunities.”
As we move into the new year, five fund pickers from the wealth management firm have highlighted the funds that they expect to perform well in 2018.
Hunt for yield – Finding an income return in the fixed interest desert
In order to generate yield, chief investment officer Thomas Becket (pictured) went for the Semper Mortgage Backed Securities fund, which is a new fund seeded by Psigma. As such, we have no data on the product but Becket believes it could be “a good source of return in the next few years”. 
“US non-agency MBS still offer a relatively high absolute and risk/adjusted return when compared to other fixed income investments; it could well be that such instruments have the best return for risk characteristics remaining in fixed interest markets after a decade of financial repression,” he added.
“The probable loss-adjusted yield for this portfolio is 4.5 per cent (net) and I would hope that the team can continue to exploit alpha generating opportunities to take total returns above 5 per cent per annum. Many of the bonds trade below par and there should be some pull to par in the next few years.”
Becket also argued that, as long as US consumers continue to pay down their mortgages and there isn’t a spike in defaults, funds such as Semper Mortgage Backed Securities should be “a fruitful investment”. To this end, moderate growth, inflation, rises in interest rates and returns on assets combined with wage prices and house prices should be supportive of non-agency MBS bond prices.
Emerging market growth - Identifying long term growth in a low growth world
Martin Ward, investment analyst at Psigma, said consumption growth in Asia is one of the best long-term themes that the firm can identify in today’s markets. He highlighted Macquarie Asian All Stars as his preferred way of gaining exposure to this theme.
“The rise of the Asian middle class is well documented and we feel this fund will enable us to take full advantage of the wonderful opportunities on offer,” Ward said.
“The fund should continue to benefit from its investments in the high quality companies linked to Asian consumption, with a focus on the local consumer, domestic demand and domestic services. Additionally, there is a big boom in Asian intra-regional travel, which we feel is only getting started and the fund is well positioned to exploit this ever growing trend.”
Performance of fund vs sector and index since launch
Source: FE Analytics
Since launch in September 2014, the $365.4m Macquarie Asian All Stars fund has generated a 53.52 per cent total return in sterling terms, outperforming its average peer in the FO Equity - Asia Pacific ex Japan sector. The fund is domiciled in Luxembourg and is not a member of the Investment Association universe.
More than 25 per cent of the portfolio is held in consumer discretionary stocks, compared with just 9.28 per cent of the MSCI AC Asia ex Japan benchmark. There’s another 5.18 per cent in consumer staples, which is a slight overweight on the index.
Macquarie Asian All Stars has an annual management charge of 1.65 per cent.
Long-term equity - The activist investor
When it comes to long-term equity exposure, the Psigma team likes Japan but prefers an investment approach that focuses on effective corporate governance changes. Senior investment analyst Daniel Adams said one fund that fits the bill in this respect is RWC Nissay Japan Focus.
Adams argued that Japan offers compelling absolute and relative value; Psigma has been positive on the country since 2011. The Japanese equity market has proven to be very divisive among investors over the past few decades, with “extreme waves of investor sentiment” often being driven by a “misplaced obsession” on the direction of the yen.
“What we consider to be a far more important development is the positive long-term change in corporate fundamentals within Japan, which have transformed Japanese equities from ‘uninvestable’ a decade ago to an exciting opportunity now,” the senior analyst said.
“Improving corporate dynamics remain in place and it is becoming clear that many companies are changing; dividends and buybacks are growing healthily and many corporate management teams are pursuing governance changes that are vital to changing investors’ perceptions of the Japanese equity market. The RWC fund directly exploits this theme by working with their concentrated list of investments to ensure improving shareholder value with company managements.”
Since launch in March 2015, the ¥29.8bn fund has made a 64.12 per cent total return, putting it in the top decile of the IA Japan sector. It also beaten the 23.97 per cent gain in the Topix (which is not its benchmark) by a significant margin.
RWC Nissay Japan Focus has a 1.25 per cent ongoing charges figure (OCF).
Inflation protection - The investor who digs a bit deeper
Inflation remained stubbornly low prior to 2017, with much market commentary focusing on the risks that potential deflation could bring to portfolios. Inflation started to pick up last year and, while Psigma sees it as being only moderately elevated in 2018, investment analyst Michael Floyd pointed out that protection against it is always important for portfolio – but arguably more so now.
“One line of defence in our portfolios is the First State Global Resources fund which invests in companies who can only benefit from higher global inflation, but also from the latter stages of the expansionary cycle,” he continued.
“The First State fund has exposure to global metals and mining stocks which should be the beneficiaries of better growth, with commodity prices picking up from what are still very depressed levels. Coupled with this, management at resource companies has improved no end, and businesses are showing much better capital discipline than before.”
Performance of fund vs sector and indices over 10yrs
Source: FE Analytics
The portfolio’s biggest exposure is to diversified metals & mining stocks at 38.6 per cent, through names such as BHP Billiton, Rio Tinto, Vale and Glencore. It also has 16.4 per cent in gold miners, which could benefit if there are any market hiccups in 2018.
As the chart above shows, the fund has posted a loss over the past 10 years and has underperformed its average generalist peer in the IA Global sector, owing to the end of the commodities supercycle and falling commodity prices. However, it has become the best performer in the peer group on a six-month view thanks to rebounding commodities prices, better global growth and improved investor sentiment.
First State Global Resources has a 0.84 per cent and is yielding 1.22 per cent.
Defence – Hedging our bets as the contrarian investor
Rory Mcpherson, head of investment strategy at Psigma Investment Management, concluded the group’s fund picks by arguing that after two years of buoyant equity markets, it makes good sense to incorporate some defence into client portfolios.
“One of our ‘protective’ picks in this theme is the Jupiter Absolute Return fund, run by James Clunie. It’s been something of a ‘sleeper’ for us this year, which is unsurprising given the environment we’ve been in of super low volatility and equity markets consistently clocking fresh highs; we’re now at a record 13 consecutive months of positive total returns for US stocks,” he said.
“From a positioning perspective, it’s giving excellent diversification: short equities, short credit, short duration and long volatility. Essentially, the manager has taken the other side to all the momentum trades which have done so well this year and we feel they’ve done a great job being able to tread water – through some good stock picking – in this environment.”
FE Analytics shows the £1.4bn fund made a loss of around 2.5 per cent in 2017, while its average IA Targeted Absolute Return peer is up more than 3 per cent. Since Clunie took over in September 2013, however, it has beaten its average peer with a 15.32 per cent total return.
Mcpherson said that factors such as rate rises, tapering and general profit taking means markets are likely to be more volatile in 2018 owing to; he noted that a “choppy market” is just the kind of environment for this fund to perform well in.
Jupiter Absolute Return has an 0.86 per cent OCF.